1927 BTA LEXIS 2667">*2667 The salaries of the petitioner's officers were increased by informal action of the board of directors with the agreement that the officers should draw only such amounts as were agreed to by the board of directors and that the undrawn portion of the salary of each should draw interest at the rate of 8 per cent. The salaries and interest on the undrawn portion were credited to the account of the officers within thetaxable years. Held that the petitioner is entitled to deduct as an ordinary and necessary expense, the amount of salary credited but unpaid within the taxable year together with the amount of the interest credited thereon.
9 B.T.A. 76">*76 In this proceeding the petitioner seeks a redetermination of its incoem and profits taxes for the calendar years 1917 to 1920, inclusive. The question is whether the respondent erred in refusing to allow the petitioner to deduct as ordinary and necessary expense of doing business, undrawn additional salaries and interest thereon at 8 per cent per annum which were1927 BTA LEXIS 2667">*2668 credited in the years in question after informal conferences of the directors.
FINDINGS OF FACT.
During the years 1917 to 1920, inclusive, the petitioner was, and still is, a corporation organized under the laws of the State of Louisiana, with its principal place of business at New Orleans.
During the years in question the directors of the petitioner were three in number, its entire capital stock being held by these same individuals, each of whom held an official position with the petitioner. Oliver H. Van Horn, who owned 75 per cent of the capital stock of the petitioner, was president, Edward F. Stauss, owning 15 per 9 B.T.A. 76">*77 cent of the stock, was vice president, and Edgar J. Haas, owning 10 per cent of the stock, was secretary and treasurer.
The company's books of account were kept on the accrual basis. The three officers kept their individual books on a cash receipts basis.
The petitioner was incorporated early in the year 1917, taking over the assets of a business that had been conducted as a sole proprietorship by Oliver H. Van Horn from 1903 to the date of incorporation. The assets were exchanged for $113.600 of stock, which were issued and continue to be1927 BTA LEXIS 2667">*2669 held in the above-mentioned proportions. No transfers of, nor increase in, the capital stock were ever made. At the time of the incorporation, Van Horn advanced $35,000 in cash to the petitioner with the understanding that he was to be paid 8 per cent interest. This interest was annually credited to him on the books of the petitioner.
Van Horn had employed Stauss in 1903 and Haas in 1904, and they remained in his employ continuously until the date of the incorporation.
The affairs of the petitioner were conducted largely through informal conferences of the three stockholder directors. The minute book is incomplete, containing many entries that are undated.
In 1916, prior to the incorporation, Van Horn received a salary of $4,800 per year, Stauss $1,860, and Haas $1,500. The business was prospering greatly as is shown by the gross sales and net earnings, which were as follows:
| Year | Gross sales | Net earnings |
| 1914 | $19,624.26 | $9,389.62 |
| 1915 | 121,144.03 | 21,302.69 |
| 1916 | 197,894.57 | 49,817.82 |
| 1917 | 473,394.26 | 92,961.29 |
| 1918 | 934,989.23 | 95,822.28 |
| 1919 | 1,036,590.09 | 134,929.39 |
| 1920 | 1,409,219.44 | 132,018.17 |
Early in 1917 Stauss and Haas took1927 BTA LEXIS 2667">*2670 up the matter of salaries with Van Horn. All three were devoting their entire time and a great deal of energy to the business. It was not unusual for all of them to work nights until twelve and one o'clock. The entire management of the business was in their hands. As a result of these conferences, the salaries of the three officers were increased to the following amounts for 1917:
| Van Horn | $14,400 |
| Stauss | 5,580 |
| Haas | 4,500 |
Salaries in accordance with the agreement were credited to the officers on the books of the petitioner during the year 1917. It was understood and agreed, however, that no substantial amount could be withdrawn without the consent of the board of directors, and 9 B.T.A. 76">*78 that the undrawn salary was to draw interest at the rate of 8 per cent. No record appears in the minute book as to the matter of interest, but the testimony shows that it was acquiesced in in order to put the other stockholders on an equality with Van Horn, who was receiving 8 per cent on the $35,000 cash advanced by him.
In December of 1917 or January of 1918, the increase in salaries was confirmed by the board of directors in the following undated resolution which1927 BTA LEXIS 2667">*2671 appears in petitioner's minute book:
The meeting of the Board of Directors of this company was called by the president and the following directors were present, Oliver H. Van Horn, Edward F. Stauss, Edgar J. Haas.
The following resolutions were adopted unanimously:
Whereas the officers of this company having faithfully performed their services and having by these efforts substantially increased the earnings of the Company, therefore be it resolved:
That their account be credited against the 1917 profits as follows:
| Oliver H. Van Horn | $9,600.00 |
| Edward F. Stauss | 3,720.00 |
| Edgar J. Haas | 3,000.00 |
and that their salary account be credited each month as follows:
| Oliver H. Van Horn | $1,350.00 |
| Edward F. Stauss | 525.00 |
| Edgar J. Haas | 435.00 |
it being distinctly understood and agreed that the increase in salary allowed by the board at this meeting is to be placed to the credit of the individual accounts and is not to be drawn except at the pleasure of the board.
No further business to be transacted the meeting adjourned.
EDGAR J. HAAS, Sec. Treas.
In 1918 the matter was again taken up at conferences and the salaries increased to the1927 BTA LEXIS 2667">*2672 following amounts:
| Van Horn | $25,000 |
| Stauss | 8,500 |
| Haas | 7,000 |
The ledger shows that these amounts, together with the interest on the undrawn balances, were credited to the respective officers.
The following resolutions appear in the petitioner's minute book:
APRIL 15/1919.
The meeting was called by the president and all stockholders were present.
Motion was made and seconded that the company purchase two new automobiles to be used by Edw. F. Stauss and Edgar J. Haas; the company to trade in or sell the two Ford automobiles now owned by said Edw. F. Stauss and Edgar J. Haas.
That the salary of the officers of the company be increased twenty-five per cent to be proportioned as follows - two and one-half times to O. H. Van Horn, three times to Edw. F. Stauss and Edgar J. Haas.
That the company repair building at 518 Camp St., to the extent of five hundred dollars.
With no further business to be transacted the meeting was adjourned.
EDGAR J. HAAS, Sec. Treas..
9 B.T.A. 76">*79 JUNE 1st/1919 At a special meeting of the Board of Directors called by the president at which all members were present, it was moved, seconded and motion prevailed that1927 BTA LEXIS 2667">*2673 -
Whereas the volume of business done during 1918 was such that it called for additional labor, both mental and physical and required attention at all times during and after business hours, therefore be it resolved - that the following increase in salary be allowed
| Oliver H. Van Horn to | $25,000.00 |
| Edward F. Strauss | 8,500.00 |
| Edgar J. Haas | 7,000.00 |
No further business before the house the meeting adjourned.
EDGAR J. HAAS, Sec. Treas.
The petitioner's books reflect the following entries:
| Year | Salary credited | Interest credited | Drawn |
| Van Horn: | |||
| 1917 | $14,400.00 | $4,800.00 | |
| 1918 | 25,000.00 | $1,257.49 | 7,086.34 |
| 1919 | 25,000.00 | 2,927.44 | 9,801.82 |
| 1920 | 25,000.00 | 4,291.16 | 12,085.22 |
| Stauss: | |||
| 1917 | 5,580.00 | 1,860.00 | |
| 1918 | 8,500.00 | 455.21 | 3,899.00 |
| 1919 | 8,499.96 | 755.92 | 6,926.00 |
| 1920 | 10,000.00 | 987.52 | 8,768.97 |
| Haas: | |||
| 1917 | 4,500.00 | 1,500.00 | |
| 1918 | 7,000.00 | 396.06 | 2,784.66 |
| 1919 | 6,999.96 | 710.30 | 4,694.08 |
| 1920 | 8,500.00 | 958.64 | 6,240.34 |
The respondent refused to allow the petitioner to deduct as ordinary and necessary expense the amount of the undrawn salaries and interest thereon at 8 per cent per annum for1927 BTA LEXIS 2667">*2674 the years 1917 to 1920, inclusive, which resulted in a deficiency of $8,908.79 for the year 1917, $19,106.83 for the year 1918, $10,539.72 for the year 1919, and $10,455.86 for the year 1920, a total of $49,011.20.
OPINION.
GREEN: The petitioner contends that undrawn salaries and interest thereon credited to the officers during the taxable years 1917 to 1920, inclusive, pursuant to agreements reached at directors' conferences are proper deductions under section 12(a) of the Revenue Act of 1917 and section 231(a)(1) of the Revenue Act of 1918, as ordinary and necessary expenses for doing buisness in the years in question. The respondent contends that as the minutes of the petitioner contain no mention of interest on undrawn salaries, no obligation was incurred, and he further contends that as the salaries could not be drawn without the approval of the directors, no present obligation was incurred which might be accrued.
9 B.T.A. 76">*80 The petitioner is a closely held Louisiana corporation. The three stockholders constitute both its entire board of directors, as well as its officers. The affairs were handled more in the manner of a partnership than as a corporation. 1927 BTA LEXIS 2667">*2675 During the years in question very few formal directors' meetings were held. The record of such meetings was poorly kept and in many instances the entries were undated. The policy of the company was determined at conferences of the three directors. The Board, in the case of , recognized the similarity of a closely held corporation to that of a partnership. The directors decided at various times that the salaries paid were inadequate. Because of the nature of the business and the large amounts of capital required, it was deemed expedient that salaries should be drawn only with the consent of the board of directors. The stockholders determined that since one of their number had advanced $35,000 and was receiving interest thereon at 8 per cent, a similar rate of interest should be allowed on all undrawn salaries. While the minute book does not reflect any such decision, the petitioner's books of account show that for the years 1918 to 1920 interest was so credited.
We are of the opinion that both salaries and interest on the undrawn portion thereof as authorized at the informal conference of the directors and as credited on the books1927 BTA LEXIS 2667">*2676 of the company, were a liability which should be accrued on the books of the petitioner and that the respondent erred in not allowing the amounts thereof as a deduction.
Judgment will be entered for the petitioner.
Considered by STERNHAGEN and ARUNDELL.